Social Security, The FICA Tax Cap, And Having Your Cake And Eating It, Too

Every time I write about Social Security and its financial woes, I inevitably get comments that the entire shortfall can be solved simply by eliminating the cap on FICA taxes, so that the wealthy pay "their fair share." After all, the Medicare portion of FICA has already had cap removed, so why not do the same for Social Security?

Here are some key facts:

In 2019, the maximum taxable earnings for Social Security will be $132,900, according to recently-released figures. Below this level, all Americans pay 6.2% of their earned income into Social Security, and their employer pay another 6.2%. Self-employed workers pay 12.4%.

According to The Social Security Game, by the American Academy of Actuaries (it's fun; you should try it), if the cap were eliminated and earnings above the cap were not credited with Social Security benefit accruals, it would make up for 88% of the shortfall. If high-income workers did receive accruals based on their above-cap pay, it would only make up for 71% of the shortfall.

The Social Security benefit formula is structured to be "progressive" -- that is, lower-income earners accrue benefits at a higher rate relative to their income than higher-income earners. Here's how it works: all of your income as recorded by the Social Security Administration is indexed, which means it's adjusted to 2018 based on national average wage increases since the year you earned it. Then the highest 35 years are averaged together (if you had less than 35 years of work, there are 0s included in the average), and then your benefit is 90% of the first $11,112 of your average indexed earnings, 32% of the next level of earnings up to $66,996, and 15% of earnings higher than this level. (See The Motley Fool for these updated-to-2019 figures.) It's the same idea as marginal tax rates, except in reverse. Which means that, while it goes without saying that if high-paid workers simply paid in more taxes without any new accrual, the additional taxes collected simply subsidize everyone else, it's also the case that even if higher earners accrued benefits on this income, they would still be heavily subsidizing lower earners -- otherwise this wouldn't be remedying the shortfall.

Removing the ceiling is consistently popular in polls. For example, a 2017 poll by the National Committee to Preserve Social Security and Medicare found that 61% of likely voters "strongly" and 13% "not so strongly" favored a proposal to "gradually require employees and employers to pay Social Security taxes on all wages above $127,000, which they don't do now" and an even higher percentage -- 69%/10% -- favored a proposal to "increase Social Security benefits by having wealthy Americans pay the same rate into Social Security as everyone else." An admittedly-leading question in a 2016 poll found that 72% of respondents supported "increasing -- not cutting -- Social Security benefits by asking millionaires and billionaires to pay more into the system." And a more academic but somewhat older analysis from 2014 found that 39% of Americans strongly favored and 40% somewhat favored eliminating the cap.

Looking at this can make it appear as if it's a no-brainer to remove the cap. Only the rich pay, and everyone else benefits. Yes, they might whine that their taxes go up by 12.4% with nothing to show for it and they're already paying higher rates, but better that than raise taxes across-the-board or force the elderly to cope with benefit cuts.

But what about the conventional wisdom that says that we need to keep the payroll tax cap (and in addition reject means testing) in order to get broad support of the system as one in which everyone contributes their fair share and has earned their benefits rather than receiving welfare?

How can such large proportions of Americans support making a change that fundamentally undoes this "earned benefits" design to Social Security, especially when the conventional wisdom is that Americans believe that, not only have they earned their benefits, but that the money they contributed was set aside to fund their own personal retirement benefits (or, alternately, would have been had Congress not "stolen" it)?

Is this cognitive dissonance? Are Americans foolishly, even ignorantly, clinging to their belief that they earn their benefits fair-and-square even when their support of removing the cap says they believe the rich should pay for everyone else? Do they want to have their cake and eat it too, by collecting subsidies while still insisting they've stood on their own two feet all along?

I don't think so.

After all, a 2017 poll found that 48% of Americans support the idea of a universal basic income, up from only 10% a decade ago, when described as a way to help people who lose their jobs due to AI. Another poll found 38% somewhat or strongly supported a $1,000/month government check paid for with a tax hike on those earning $150,000 or more.

These UBI supporters are still in the minority, but the idea's popularity is increasing, and it appears to be just one way out of many in which people are growing increasingly comfortable with the idea that the middle-class should receive government benefits, not (just) the poor. And once people are comfortable with the idea of "middle class welfare," then it stands to reason that they'd consider the right solution to the funding deficit to be one requiring the wealthy to top up the system however much is needed? In such a case, they might be viewing their benefits as "earned" in a more metaphorical/symbolic sense, in which they have a right to them by having been a hardworking American during their working lifetime, regardless of what the math shows.

If the payroll tax cap is removed, it will not be a matter of having the wealthy pay "their fair share." It will be a shift towards, or a recognition of (depending on your perspective) FICA taxes being taxes, nothing more or less. And in that case, why not integrate it all into our regular income tax structure, with the same marginal tax rates, deductions, taxation of investment income, and the rest?

Side note: I tried to find polling on the extent to which Americans understand that Social Security is fundamentally a pay-as-you-go system with modest reserves having been built up by past surpluses, rather than a genuinely prefunded system, and is a system with significant subsidies from one group to another (not just by the benefit formula, but subsidies from singles to families and from dual-earner to single earner couples, as well), but there's not much out there. Polls intending to determine Social Security knowledge, such as this Mass Mutual survey, ask about such practical items as retirement ages and spousal benefits. One 2010 survey does ask a more basic question and finds that roughly a quarter of Americans believe that benefits are based on contributions plus interest, one half either answer correctly or a rough approximation of the correct answer -- that is, either an average of the highest 35 years of earnings or a private pension-like 5 year average pay times working years -- and one quarter don't know; it does not ask whether people think the system is funded or pay-as-you-go, or whether they think their benefits are proportionate to their income. But without more survey questions, we're left to draw conclusions from such sources as viral Facebook posts, including one, a variant on a Snopes-fact-checked version, that came across my Facebook feed recently and insisted, "This is NOT a benefit. It is OUR money , paid out of our earned income! Not only did we all contribute to Social Security but our employers did too ! . . . This is your personal investment."